3 myths about tax extensions

Sometimes filing a tax extension can be a benefit to your clients, but only if they are clear on what an extension means —and what it doesn’t mean.

If you’re a tax CPA, you’ve probably come across a client who chose not to file an extension because they misunderstood how it would affect them. On the other hand, maybe a client was happy to go on extension but for the wrong reasons.

Below are three myths that your clients may have about extensions that you can proactively dispel.

Myth #1: If I go on extension, I can wait until the return is filed to pay.

Your client may not realize that although they have extra time to file, they don’t have extra time to pay. These clients are confident they don’t owe anything, so they do not want to make a tax payment with the extension. They are sometimes in for an unpleasant surprise after a Schedule K-1 arrives that summer, showing income that they did not expect. Now they owe penalties on top of the tax payment. Ouch.

In some cases, this common misconception is mixed in with payment anxiety. Some taxpayers find themselves in a position where it’s difficult to pay a tax bill all at once. They may not always mention this, so it’s important to stress that payment cannot be delayed but installments are an option.

Gerard Schreiber, CPA, recommends that CPAs should send a letter to clients who will need to file for an extension that spells out the client’s responsibility to pay estimated taxes to avoid penalties. He requires his clients to sign the letter before filing the extension to eliminate issues that may arise later such as complaints about late payment penalties.

Myth #2: Going on extension is expensive.

One of the main advantages you can stress to a client who needs to go on extension is that the return will likely be more accurate because it reflects up-to-date information and is not finalized in a rush. This means an amended return (prepared at extra cost) will not be necessary. The client may also save money by allowing time to see if more deductions can be claimed. Additionally, self-employed clients benefit from an extension because they will have more time to fund a SEP IRA, solo 401(k) or SIMPLE IRA retirement plan.

Because they believe an extension may be expensive, clients may resist the idea and plead for more time, offering to get the needed information to you soon. One of the best ways to address this issue is to use an engagement letter for the client to provide tax information. The deadline should also be accompanied by a clear statement that if all information is not received by that date, the client may need to go on extension and will face late payment and interest penalties for amounts not paid by the filing date.

Myth #3: Filing a return after the April deadline makes me more susceptible to an audit.

Lawrence Carlton, a CPA who runs a practice in Massachusetts, has occasionally fielded this question. “It really is a myth,” says Carlton, who also serves on the AICPA’s IRS Advocacy Relations Committee. “Your chances of an audit are not related to the timing” of the filing.

Instead, it is a rating scale that determines the audit. The IRS assigns returns a Discriminant Inventory Function (DIF). The IRS is understandably tight-lipped about the details of DIF, but the bottom line is that the score reflects potential red flags that are on the agency’s radar, such as a high level of charitable contributions compared to reported income.

This year adds a new angle to tax extensions with the passing of the Tax Cuts and Jobs Act and the Bipartisan Budget Act of 2018. There are provisions in each law that affect 2017 returns, which creates confusion as to what certain taxpayers should do as well as uncertainty about how some states will conform to the changes. The IRS is working on implementing this major tax legislation, which should alleviate some of the confusion and allow for more successful tax planning and strategic moves.

Still need a few more talking points when discussing extensions with your clients? Download these FAQs for clients from the AICPA Tax Practitioner’s Toolkit and share with your clients to shed some light on the topic.

And once you’ve addressed your clients’ concerns, take a few minutes to refresh yourself on some of the rules and procedures listed below for return preparation, including those related to extensions.

SSTS No. 4, Use of Estimates is useful for working with estimated amounts of income and deductions.

SSTSs 1, Tax Return Positions and No. 2, Answers to Questions on Returns provide more insight into due diligence in the preparation of returns.

Circular 230 Sections 10.22, Diligence as to accuracy, and 10.36, Procedures to ensure compliance, mandate considerations to be followed in the preparation of federal returns, including extensions by practitioners.

Best of luck as you head into the final stretch of busy season.

April Walker, CPA, CGMA, Lead Manager, Tax Practice & Ethics, Association of International Certified Professional Accountants

Tax extensions courtesy of Shutterstock.

3 myths about tax extensions

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